Debt Settlement

Debt settlement is an arrangement between the lender and the borrower, according to which the borrower pays a lump sum or one-time payment, which is less than the actual amount due to settle the debt once and for all. These services are provided by third-party companies who negotiate on the borrower's behalf with the creditor on settlement terms.

When a borrower does not have the resources to repay the debt and wants to ensure that they do not get sued by the lender, they try to negotiate a deal to settle the amount instead. A debt settlement agreement is a high-risk option and leads to a sharp decline in borrowers' credit ratings.

• Debt settlement is an agreement between the borrower and the lender in which the borrower makes a one-time payment of less than the whole amount owed to settle the debt.
• The services are provided by independent businesses that speak with the creditor on the borrower's behalf when discussing the settlement conditions.
• The borrower's credit ratings significantly drop due to this high-risk decision.
• Do it yourself, transferring the sum, and non-profit credit counseling are some alternatives to debt settlement.

Debt settlement refers to a one-time or lumpsum payment given by the borrower to the lender after a detailed negotiation directly or with the help of a debt settlement lawyer as the former does not have the resources to repay the remaining amount of the loan.

If a debtor is struggling to pay their unsecured debt like credit card debt, personal loans, etc., they can approach debt settlement companies. These companies negotiate on the borrower's behalf to settle the deficit with a reduced amount. This company holds the payment from the debtor to pay the debt in the negotiation period. And when the debtor is in default on all the accounts, these companies can force the creditor to accept a reduced lump sum amount to settle their debt.

That leads to a sharp decline in the debtor's credit rating during the negotiation period when the debt settlement company is holding the payment from the creditor, which will have an impact for several years. Still, some debtors prefer this over bankruptcy.

Debtors struggling to pay their debts reach out to debt settlement companies. This service is offered by a third-party company unrelated to the creditor. These companies offer to negotiate the terms of debts with creditors on the debtor's behalf. They arrange for better payment terms or debt settlement with a reduced amount.

This company instructs the debtor to make a regular deposit to a separate account and withhold payment until the creditor's payment term is negotiated. This deposit helps debtors later at the time of the final settlement. Once the conditions are dealt with, the company asks the debtor to make a lump sum settlement for one of their debts for the reduced amount. And they charge a percentage of fees on the amount that the debtor saves.

Let us understand the effects of hiring a debt settlement lawyer with the help of a couple of examples. These examples will give us a practical understanding of the concept and its related factors.

Example #1

Joe is struggling pay his monthly unsecured loan and has no balance left in his account. The debtor has monthly earnings of $10,000, but after meeting all the necessary expenses, $5,000 is left at his disposal, which is insufficient to pay the monthly debts of $7,000.

The debtor reaches out to the debt settlement company to negotiate with the creditor for better payment terms or settle the debt by paying a lower amount. Finally, the company will advise the debtor to make a regular payment of $5,000 in a separate savings account and stop paying the creditor altogether.

After four months, the settlement company would have collected $20,000 from the debtor. At that time, it will ask the creditor to accept the lump sum payment of $15,000 on the debtor's behalf and settle the debt. The creditor did not receive the compensation for the last four months. Therefore, they may have written off the amount and can accept the lump sum payment of $15,000 to settle the debt. That will forward $15,000 to the creditor and keep $5,000 as fees for negotiations.

Example #2

Plymouth Rock Technologies Inc., a company that develops exclusive Intellectual Properties (IP) for the aviation sector hired Canaccord Genuity Corp. as consultants for a couple of projects.

They were unable to pay their fees which amounted to $169,000. Therefore, after lengthy negotiation, it was decided that the former will settle the debt by issuing company shares in the company’s name as a one-time settlement for the debt.

They issued 2,600,000 shares at a price deemed at $0.65 per share. Despite the settlement, Plymouth’s director Dana Wheeler issued her resignation and appointed Alan Treddenick as her successor.

Despite the fact that a debt settlement agreement allows the debtor or borrower to settle the debt at better terms for them, there are significant repercussions of this action. Let us understand the risks associated with such settlements through the discussion below.

• This option will severely impact the debtor's credit risk rating, and the mark will remain for several years.
• The debtor will have to pay the debt settlement company high settlement fees.
• Even after reaching out to the settlement company, the debtor will have to continue to pay the monthly payment for a long duration.
• There is no guarantee of success in getting a negotiated term.

It has been established and reiterated through the article so far that the services of a debt settlement lawyer are of great benefit for the borrower. However, there are alternatives to this process and one must consider them before entering into any such agreements.

1. Do It Yourself: Debtors can try negotiating the settlement with creditors by offering the amount they can pay immediately, typically less than what is due.
2. Transferring the Balance: The debtor can offer an introductory offer on a new card of 0% or lesser interest for the promotional period and transfer the balance. But they should pay the debt during the promotion period to avoid paying high interest.
3. Non-Profit Credit Counseling: Debtors can reach out to non-profit payment counseling agencies as they do not charge hefty fees. However, they do not negotiate to reduce the debt. Instead, they arrange for better payment terms and the cessation of late payment fees.

Any concept or facet in the world of business has two sides of the spectrum to it. Let us understand the pros and cons of entering into a debt settlement agreement with the help of the points below.

Pros

• It saves the debtor from bankruptcy and its stigma.
• It helps the debtor finally pay off the debt and get creditors off their back.
• It lowers the total debt amount.

Cons

• It severely impacts the debtor's credit score.
• These companies charge hefty fees, and thus, it can cost more to the debtors.
• There is no guarantee that the debt settlement company will negotiate reduced debt.
• There can be tax consequences for the amount not paid to the creditor under the negotiated settlement term.
• There is a potential risk of a lawsuit from the creditor's side.

Both debt settlement agreement and a debt consolidation help the borrower or debtor get a better deal with regard to repaying their loans. However, there is a difference in their fundamentals. Let us understand the differences through the comparison below.

• Debt settlement is the settlement of debts by paying a lump sum amount less than the actual debt amount. The service is provided by a third party, a settlement company, against a fee, typically a percentage of the remaining debt or the saved amount.
• The debt consolidation option combines several debts into one and takes out a single loan with a lower interest rate and lesser monthly payment to pay the debt. Debtors avail of this option to manage their secured and unsecured debts.

This article is a guide to what is Debt Settlement. We explain its pros, cons, examples, and alternatives, and compared it with debt consolidation in detail. You can learn more about it from the following articles: -

• Distressed Debt
• Debt Relief
• Debt Instruments
• Debt Consolidation